Windfall tax weighs heavy on North Sea producers

Investment in the UK’s North Sea has been damaged by a windfall tax on producers that also threatens to derail mergers needed to help the sector survive, industry bosses and analysts have said.

Shares in UK-focused producers have slumped despite a 30 per cent rise in the MSCI’s global energy index since Russia invaded Ukraine in early 2022, and government data shows a big drop in their profitability.

While there has been an 8 per cent rise in the price of crude oil since the end of 2021, the gross operating surpluses of North Sea operators fell from £11.1bn in the third quarter of 2022 to £2.3bn in the final three months of 2023.

The UK introduced an “energy profits levy” on oil and gas producers in May 2022 with the aim of raising an initial £5bn, after an outcry over record profits at BP and Shell. In March, it was extended by a year to end in 2029. Including this 35 per cent levy, industry profits are now taxed at 75 per cent in the UK.

The smaller independent operators that mainly work the North Sea — after the majors retreated in recent years — say they have taken the brunt of the pain from the high tax rate because UK waters account for a bigger proportion of their operations. They argue that benefits from oil price movements since the start of the Ukraine war have generally accrued to the majors, which have diversified businesses, and trading companies.

Many in the industry are worried about the future for investment in the UK’s ageing basin.

“When I started out in this industry there were only major companies mostly with global presence operating in the north sea but in recent years they have all been moving out,” said Mark Lappin, chair of Deltic Energy, who has been in the industry for more than 40 years.

UK oil and gas production was just over 1.2mn barrels a day equivalent last year, its lowest since 1977, according to trade body Offshore Energies UK, which estimates that a further loss of investment in the sector could cost 40,000 jobs by the end of 2030. The body estimates that the industry supports 200,000 jobs, down from about 500,000 a decade ago.

“There are many [producers] that have exited, or are exiting the UK,” said Amjad Bseisu, chief executive of independent operator EnQuest and a former UK business ambassador for energy. “The continuous decline in production and jobs isn’t good from a macro perspective.”

Energy consultancy Wood Mackenzie said buyers had shown “little appetite” to expand in or to enter the UK continental shelf and estimated that £16bn in potential investment could be lost because of uncertainty about tax policy.

The Labour party, which is currently favourite to win the next general election, has proposed increasing the total tax rate to 78 per cent and removing tax relief on new projects.

The industry is likely to feature in election campaigning in Scotland as a weakened Scottish National party seeks to ward off challenges to its dominance.

In one of the few major deals in the UK North Sea since the introduction of the windfall tax, London-listed Ithaca Energy last month agreed to buy almost all of the UK upstream operations of Italian major ENI for about £750mn. This includes the UK assets of Neptune Energy, which ENI agreed to buy last year for $4.9bn.

Under the deal, ENI will receive a 38 per cent stake in the enlarged group.

Chris Wheaton, oil and gas analyst at Stifel, said consolidation in the sector was an essential “defensive move” that would allow companies to combine resources and fund the decommissioning of old assets.

“The UK needs a national champion to manage the decline [in oil and gas production],” he said, adding that while two Norwegian groups — Equinor and Aker BP — accounted for about four-fifths of production in Norway, the top five in the UK were responsible for 45 per cent.

While Labour’s proposed tax rate is the same as that in Norway, analysts argue that Norway has a less mature basin, which makes is cheaper to exploit, generous investment allowances and a tax regime that has not changed for more than three decades.

“After four tax changes in two years . . . the appetite for investment in the UK continental shelf is in a worrying place,” said Ryan Crighton, policy director at Aberdeen & Grampian Chamber of Commerce.

UK-focused producers are trailing a 30 per cent rise in the MSCI World Energy Sector Index since the start of Russia’s Ukraine invasion. Shares in Serica Energy are down 37 per cent, while Harbour Energy, the biggest independent UK producer, has lost 23 per cent.

Gilad Myerson, executive chair of Ithaca, said the prospect of unexpected changes in taxation meant it was “easier to do mergers” than pursue acquisitions that are funded with cash.

Column chart of Oil & gas wells drilled showing North sea drilling activity has continued to decline

“Before you consolidate, you have to put a value on the assets, and it’s very difficult to do that if you don’t know what the fiscal regime is going to be,” said Mitch Flegg, the former chief executive of Serica, who has become an adviser to the company.

Australia-listed Hartshead Resources, one of the smallest producers in the UK North Sea, said earlier this year that it had cut jobs on a gas project in the North Sea because of uncertainty about taxes. Chris Lewis, chief executive, told the Financial Times the company had delayed awarding contracts for the project.

“That has a direct impact on jobs, on supply chain companies in the UK, and on receipts to the exchequer because if you delay our gas production, you delay us paying tax on it.”


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